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Loan Reluctance Poses Problems
A growing mountain of idle cash at China's financial institutions, partly the result of a widespread reluctance to lend, led to problems that call for immediate action, as analysts have long been crowing.

Overall loan activity slackened significantly last year as increasingly risk-averse commercial banks tightened loan-approval procedures and their efforts to trim staff temporarily disrupted lending operations, bankers said.

These factors, coupled with strong increases in savings deposits, generated an unexpected surplus of funds, which, largely due to strict regulatory rules, were mostly poured into bond markets last year to underwrite and trade treasury bonds.

Bond interest rates were hammered down to levels below bank deposit rates and prices on the secondary market were deeply mired, suggesting potential losses for banks and eventually drawing attention from the central bank.

In a rare, outspoken sign of concern the People's Bank of China (PBOC) warned in its second-quarter monetary policy report in August that "certain risks exist in financial institutions holding large amounts of low-interest-rate treasury bonds."

"(The PBOC's warning) was targeted at the excessively low interest rates (on bond issues) since the second half of last year," said Ma Junsheng, a manager with the Industrial and Commercial Bank of China (ICBC). "Funds at that time were really loose."

The central bank's open warning came after hints of dissatisfaction on informal occasions failed to stop banks from snapping up treasury-bond issues by bidding with lower rates, insiders said. Financial institutions held 936.7 billion yuan (US$113 billion) in outstanding treasury bonds at the end of May, up 12.2 percent from the end of last year. The majority was held by commercial banks.

One four-year treasury bond issue floated in April carried a mere 2.22 percent coupon, as compared to the 2.79 percent interest rate paid on four-year bank deposits.

"The continuous downtrend in interest rates on treasury and financial bonds, and the fact that most of them carry fixed rates, have magnified the interest rate risks and liquidity risks in commercial banks' bond portfolios," said Huang Jinlao, a researcher with the Institute of International Finance under the Bank of China.

"Whether the risks become reality depends on the medium- and long-term possibility for a reversal in China's low interest rate situation," he said.

China's interest rates are currently at historic lows after eight cuts since 1996 aimed at boosting economic growth amid global sluggishness. While most economists say rates are unlikely to be changed in the near term, as deflationary pressures show no sign of ebbing, they say the longer-term outlook is upward.

Capital remains a scarce resource in China in the medium- and long-term and the high personal savings rate, which boosted total savings deposits past a staggering 8 trillion yuan (US$967.3 billion) earlier this year, is hardly sustainable.

Inflation, another key economic variable that would be no surprise if seen at around 2 percent during strong growth periods, could easily offset the already paltry yield on the treasury-bond holdings of commercial banks. And the banks would still have to pay interest on deposits.

"Do you really believe that we can keep inflation in the coming five to seven years below 2 percent?" Dai Genyou, PBOC's monetary policy department chief, was quoted by an insider as asking bank executives at a recent meeting.

Bond coupons in the first half of the year varied from 1.9 percent on a two-year-term issue to 2.9 percent on a 30-year-term batch, all much lower than their equivalents in the United States.

Yet insiders said the market started a rally during the past month, as commercial banks became aware of the growing risks and perhaps more importantly, many of them already scratched the bottom on deposit excesses that can be invested rather than stashed with the central bank as reserves.

Insiders said only a few commercial banks, including the ICBC, the Agricultural Bank of China and the China Construction Bank, still have extra cash to underwrite treasury bonds, making a further rebound in bond yields a likely scenario should they refrain from undercutting each other.

(China Daily September 2, 2002)

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